Looking for your first home to buy is an exciting time in anybody’s life. It’s also a very daunting process, after all this is likely to be the biggest purchasing decision you’ll make in your entire life (no pressure). Avoid the most common mistakes made by first-home buyers with these five steps.
1. Get a copy of your credit report from all three credit bureaus and check for errors
You can get a free copy of your report from TransUnion, Equifax and Experian once per year for free from the government endorsed site annualcreditreport.com. Before you start looking for houses it’s vital you check all three of these reports for any errors. An error on your credit report could affect your chances for being approved for a loan or the rate of interest a lender offers you. In 2013 an FTC study found that up to 5% of consumers had errors on their credit report which could cause them to get less than favorable terms.
If you do find an error on your credit report, you’ll need to dispute it with both the credit bureaus and the data furnisher who posted the incorrect information. You can dispute incorrect information online by clicking here. Credit bureaus have a period of 45 days to respond to your dispute, so make sure you leave plenty of time between this first step and when you start looking for a new home.
2. Find out your three major FICO® Scores
Applying for a home loan is one of the few times that a lender will check your FICO Scores from each credit report, so it’s important that you do your due diligence and do the same. The reason you’ll want to know your score is that it’ll affect the interest rate you’re offered by lenders.
For most lenders, the gold standard is an average score of 740 or above. When we say gold standard, we mean that you’ll be given the best rate that lender offers (which incidentally is usually the interest rate published on their website or marketing materials).
If you don’t have that magical score of 740 and above, all hope is not lost. As your score decreases the chance you’ll become delinquent increases. This means the lender has a greater risk that you’ll default on your mortgage and they’ll charge you a higher than advertised APR as a result. You can see how much of a difference this’ll make by using this mortgage calculator by myFICO.
For those with lower FICO Scores your best bet is to try and get your loan through a financial institution that you have an existing relationship with (e.g the institution you do your everyday banking with) as they have access to a complete view of your banking relationship with them.
3. Decide on your budget
When looking for a house one of the most important things to do is to create a budget and stick to it. It’s much easier if you create this budget before looking at houses, this way you won’t be swayed to increase your budget to something you can’t afford because a certain house falls outside this budget.
There are three main things which will decide your budget for a house:
- Down deposit that you have saved up
The type of loan (FHA, VA etc.) will also determine the minimum down deposit you’ll be able to put down. You’ll also want to make sure you’ll be able to meet the minimum monthly repayments of whatever loan you get. To do this work out your income and then minus your monthly expenses (excluding things like rent which you won’t have to pay once you move into your new home). For example, monthly salary is $4,250 and fixed monthly expenses are $2,000. This leaves us with $2,250 per month for servicing a loan and other unexpected emergencies.
Once you know this use one of the many mortgage calculators out there to find out how much your monthly payments will be with different interest rates and loan amounts. We suggest using the myFICO how much can I borrow calculator as it’ll do all of this math for you and spit out a number you can likely afford.
In general most people can afford to purchase a house that is two and a half times their combined annual salary. So if you earn $35,000 and your wife earns $65,000 then you’ll be able to afford a house of $250,000. It’s always preferable to own a place that is under your budget than getting a place that will stretch you too thin.
4. Make sure you have a safety net
Before you start house hunting, you should make sure you have an emergency fund built up. Owning a house is expensive and you cannot truly understand the unexpected expenses until you own a place of your own. For example, if the boiler stops working you’re looking at close to $3,000 to get a new one fully installed.
Regardless of whether you’re applying for a home loan, you should always have a safety net built up for those unexpected emergencies (job loss, ill health, etc.). I recommend having at least three months wages saved in an interesting-bearing checking or savings account, with six months being preferable.
5. Get pre-approved
Generally when somebody puts their property on the market they want to sell as quickly as possible. If you’re not pre-approved for a mortgage there is a good chance there will be delays which could end up costing the seller money. A pre-approval letter or statement also shows real estate agents & sellers that you are a credible and qualified buyer which can make setting appointments or viewings much easier.
A mortgage pre-approval is a letter or written statement from a financial institution that a borrower qualifies for a particular loan amount under the lender’s guidelines. These pre-approvals typically last for a period of 60 to 90 days, depending on the lender.
To receive pre-approval you’ll need to provide a mortgage lender with the following information:
- Full name & current address
- Current and past income (usually last 18 months – two years). This usually needs to be verified, either through pay stubs or tax forms
- Permission to pull your credit report
Some lenders will ask for more or less information, but this is usually the basic stuff that is requested.
If you’re in the market for a new home or want to upgrade your existing home, I wish you the best of luck with it. If you follow these tips I’m sure you’ll not only get the best mortgage rate possible but you’ll end up paying off your mortgage much quicker than you otherwise would’ve been able to.
William Charles is the main contributor to Doctor of Credit and a staunch consumer credit advocate. He blogs on anything from credit scores to credit security issues to chase coupons. He’ll be sticking around to answer any & all of your comments, so feel free to ask away.